Chapter 10 Making Capital Investment Decisions

Incremental cash flows is the difference between the cash flows a company will have if it implements the new project versus the cash flows the company will have if they choose not to embark

Capital planning and budgeting is a very vital piece in the Public Budgeting System process. It is an essential implement in the financial management practice and is effective in both public and private organizations. It is the method which consists of the determination and the evaluation of the investments and the possible expenses by an organization. As explicate by Lee, Johnson, & Joyce (2008), capital budgets help in determining how much of each form of investment is needed, and it supports an organization in assessing the available revenue which includes loans is required to finance those investments (p. 475). Capital budgeting is a central part of the universal

The statement of cash flows presents investing and financing activities so that even noncash transactions of an investing and financing nature are disclosed in the financial statements. If they affect financial conditions significantly, the FASB requires that they be disclosed in either a separate schedule at the bottom of the statement of cash flows or in a separate note or supplementary schedule to the financial statements.

We focus on free cash flows rather than accounting profits because these are the flows that the firm receives and can reinvest. Only by examining cash flows are we able to correctly analyze the timing of the benefit or cost. Also, we are only interested in these cash flows on an after tax basis as only those flows are available to the shareholder. In addition, it is only the incremental cash flows that interest us, because, looking at the project from the point of the company as a whole, the incremental cash flows are the marginal benefits from the project and, as such, are the increased value to the firm from accepting the project.

It is calculated by taking the present value of future cash flows minus the initial investment (Byrd, 2012). George has statements from previous years that document cash flows and business cycle trends. These statements include the timing and magnitude of cash flows, which include increased cash flows in the summer due to tourism, and reduced cash flows during income tax time. Using previous cash flow statements can help anticipate and calculate future cash inflows of a potential investment, such as the purchase of a Race Car or small train line, and can provide George with an accurate picture of the project 's Net Present Value.

A. The company needs to focus on the free cash flows instead of the accounting profits since these are the funds flow the company will receive and will be able to reinvest. By examining the cash flows they will be adapt to predict the profits and/or expenses timetable. The company’s interests in these cash flows are on an after-tax basis since they are part of the shareholders dividends. Additionally, the additional cash flows are of important, because, after analyzing the project while viewing the company as a whole, the additional cash flows are seen as minimal benefits and will show the elevated value to the company if the decision is made to implement the project.

Constructing Free Cash Flows allows the calculation for NPV, which enables an even comparison of inflows and outflows of the competing projects. EBITDA does not take into account the Income Tax. Unlevered Net Income (ATCF) does not account for the separation of depreciation, capital expenditures, and changes in Net Working Capital.

417). In other words, these are the cash flows that will only occur if we do accept the project.

Virtually all general managers face capital-budgeting decisions in the course of their careers. Among the most common of these is the either/or choice about a capital investment. The following describes some general guidelines to orient the decision-maker in these situations.

1. Incremental cash flows are ultimately the relevant cash flows to be used in project analysis. It is the difference between the cash flows the firm will have if it implements the project, and the cash flows the firm will have if it rejects the project. Although they are a cash expense, interest expenses are not included in project cash flows. We discount a projects cash flows by using its weighted average cost of capital (WACC), which already includes the cost of debt. Therefore, we do not include interest expenses in cash flows because it would essentially be counting them twice.

5. If debt is used to finance this project, should the interest payments associated with this new debt be considered cash flows?

a. Capital budgeting is the process of analyzing projects and determining which ones to accept and include in the capital budget.

1. Define the term “incremental cash flow”. Since the project will be financed in part by debt, should the cash flow analysis include the interest expense?

Capital budgeting is the most important management tool that enables managers of the organization to select the investment option that yields comprehensive cash flows and rate of return. For managers availability of capital whether in form of debt or equity is very limited and thus it become imperative for them to invest their limited and most important resource in perfect option that could prove to beneficial for the organization in the long run (Hickman et al, 2013). However, while using capital budgeting tool managers must understand its quantitative and qualitative considerations that are discussed below.

| Below is an excerpt from the cash flow statement of a firm for fiscal year 2003: Cash flows from operating activities: Net income Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization Amortization of software Tax benefits of employee stock plans Special charges (Gains)/losses on investments Change in operating assets and liabilities: Receivables Inventories Pension assets Other assets Accounts payable Pension liabilities Other liabilities Net cash provided by operating activities Cash flows from investing activities: Payments for plant and other property Proceeds from disposition of plant and other property Investment in software